What Are Funding Rates?
The funding rate is a special mechanism applied in the perpetual swap market. It’s mainly used to narrow the difference between the perpetual contract prices and spot prices. Funding rates are periodic payments made to either long or short traders, calculated based on the difference between the perpetual contract prices and spot prices.
Features of Funding Rates
1. The funding fee is not a fee charged by the trading platform, but rather is a payment made between perpetual swap traders.
2. Funding rates vs. funding fees: when the funding rate is positive, traders who are long on a perpetual contract (buyers) will pay a funding fee to traders on the opposing side (sellers); when the funding rate is negative, traders who are short on a perpetual contract will pay a funding fee to long traders; when the funding rate is zero, no funding fees need to be paid between the two parties.
3. Each exchange has its own timer for calculating the funding fees that need to be paid or received by traders. If traders do not have a position at the funding times, they are not liable for funding payments in either direction.
For instance, funding payments occur every 8 hours at 00:00 UTC; 08:00 UTC and 16:00 UTC for all FUTX Futures perpetual contracts. If traders do not have a position at the above three funding times, they are not liable for funding in either direction.
4. Funding rates are automatically calculated by the platform. Users can view the real-time and historical funding rates on FUTX at any time.
About the Funding Rate Mechanism
The formation of the funding rate mechanism is associated with the properties of the perpetual swap market. The most significant difference between a perpetual contract and a traditional futures contract is that perpetual futures have no expiry or settlement date. This means users can hold positions in perpetuity unless they get liquidated. However, the expiration date or delivery date, plays a vital role in the traditional futures contract trading, i.e., ensuring that contract prices correspond to the value of the underlying asset. As the delivery date approaches, the settlement mechanism will force the convergence of prices between the futures contract and the underlying asset.
How does the perpetual swap market keep the contract price in line with the price of the underlying asset? This is where the funding rates come in. To put it simply, the funding rate mechanism for perpetual futures contracts is similar to the settlement mechanism applied to the traditional futures contract market. These two mechanisms are designed to force contract prices to be pegged to spot prices, ensuring consistent price difference between futures and spot markets, and avoid extreme price deviation led by futures price manipulations.
Using the funding rate mechanism, funding fees hold the key to keeping the price of the contracts consistent with the spot price of the asset. When there is a price deviation, funding fees will forcibly pull the price difference back into a rational level. For example, when a perpetual contract price is too high, the funding rate will be positive, and sellers will face increased trading risks due to the high price gap. As a result, buyers must compensate sellers by paying the funding fees. As a huge price gap will lead to extra trading costs, it pays effectively eliminate the phenomenon of contract price manipulations, enforcing price convergence between the futures and spot markets.
What’re Funding Rates’ Impact on Traders?
Funding rates can make a significant dent in the trading costs and earnings potential of futures traders. The greater the holding size is, the more funding fees traders need to pay. As traders trade futures with leverage, if the leverage is too high, traders who pay the funding fees will also suffer great losses despite low market volatility.
On the other hand, as for the side who receive the funding fees, funding fees can also serve as a key source of income, especially during market swings. It’s possible for traders to earn profits by formulating corresponding trading strategies based on funding rates.
Funding Rate Calculations on FUTX
1. Funding payments occur every 8 hours at 00:00 UTC; 08:00 UTC and 16:00 UTC for all FUTX perpetual futures contracts. If traders do not have a position at the above three funding times, they are not liable for funding payments in either direction.
2. There are two components to funding rates: the interest rate and the premium. The funding rate = the premium/the index price
3. Funding rates are updated every 60 seconds (“Predicted funding rates”).
4. The upper and lower funding rate limits for BTC futures contracts are 3% and -3%, respectively. For other futures contracts, the limits are 5% and -5%, respectively.
5. Funding fees are settled in USDT.
6. Funding fees = funding rates * index price * holding size
